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Liquidity and asset-use ratios

Edexcel IAL Accounting · WAC11 The Accounting System and Costing

Liquidity ratios show whether a business can pay its short-term debts; asset-use (efficiency) ratios show how well it manages inventory, receivables, payables and non-current assets (spec 1.5.1).

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Liquidity ratios

Ratio	Formula	Example
Current ratio	Current assets : current liabilities	48,000 : 24,000 = 2.00 : 1
Liquid (acid test) ratio	(Current assets - inventory) : current liabilities	26,000 : 24,000 = 1.08 : 1

Asset-use ratios

Ratio	Formula	Example
Rate of inventory turnover	Cost of sales / average inventory (times)	156,000 / 20,000 = 7.80 times
Trade receivables collection period	Trade receivables / credit sales x 365 (days)	25,000 / 200,000 x 365 = 45.62 days
Trade payables payment period	Trade payables / credit purchases x 365 (days)	18,500 / 150,000 x 365 = 45.02 days
Revenue to non-current assets	Revenue / non-current assets (times)	240,000 / 160,000 = 1.50 times

Average inventory = (opening + closing) / 2

Interpreting them

A current ratio around 1.5 to 2 : 1 and a liquid ratio around 1 : 1 are often quoted as comfortable, but it depends on the trade: a supermarket sells inventory for cash quickly and can run lower ratios.
Too low: risk of not paying suppliers and staff; too high: money tied up in idle inventory, receivables or cash that could earn a return.
Include the bank overdraft in current liabilities (a common error in the 2024 exam).
Inventory turnover: higher means goods sell faster (less risk of obsolescence); a fall may mean overstocking or slow sales.
Collection period longer than the credit terms given suggests weak credit control; compare with the payment period: collecting cash more slowly than paying suppliers strains liquidity, while delaying payments too long risks losing suppliers' goodwill and discounts.
Revenue to non-current assets: how much revenue each £1 of non-current assets generates.

Worked example

Comment on the collection and payment periods in the example.

Customers take about 46 days to pay; the business takes about 45 days to pay suppliers.
The two are close, so cash flows in roughly as fast as it flows out.
If the business allows 30 days' credit, customers are paying late and credit control should be tightened.

Answer: Periods are similar, but both should be compared with the credit terms and with last year.

Key idea: Current ratio = CA : CL. Liquid ratio = (CA - inventory) : CL. Inventory turnover = cost of sales / average inventory. Collection and payment periods use credit sales and credit purchases x 365.

Check yourself

Current assets £64,000 (including inventory £28,000); current liabilities £40,000 including a bank overdraft of £6,000. Calculate the current ratio (to 2 decimal places, as x : 1).
Show answer
1.60. 64,000 / 40,000 = 1.60 : 1. The overdraft is included in current liabilities.
Using the same figures, calculate the liquid (acid test) ratio.
Show answer
0.90. 36,000 / 40,000 = 0.90 : 1.
Cost of sales £126,000; opening inventory £16,000; closing inventory £20,000. Calculate the rate of inventory turnover.
Show answer
7.00 times. Average inventory 18,000; 126,000 / 18,000 = 7.00 times.
Trade receivables £14,600; credit sales £146,000. Calculate the trade receivables collection period in days.
Show answer
36.50 days. 14,600 / 146,000 x 365 = 36.50 days.
Trade payables £9,800; credit purchases £84,000. Calculate the trade payables payment period in days.
Show answer
42.58 days. 9,800 / 84,000 x 365 = 42.58 days.
Revenue £300,000; non-current assets at carrying value £240,000. Calculate revenue to non-current assets.
Show answer
1.25 times. 300,000 / 240,000 = 1.25 times.
A business has a current ratio of 4.5 : 1, mainly because of large inventory. What is the main concern?
- It cannot pay its short-term debts
- It is making a loss
- Money is tied up in inventory that could be used more productively
- Its gross margin is too high
Show answer
Money is tied up in inventory that could be used more productively. Very high liquidity can mean idle resources and a risk of obsolete inventory.

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Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (issue 2), Unit 1 and Appendices 6 to 8

Last updated 8 November 2026. Spotted a mistake? Tell us.